AGL makes $3 billion bet on limited climate action

AGL Energy, the power utility that has recent years boasted of having one of the cleanest and greenest energy portfolios in the country, has announced the purchase of Loy Yang A – Australia’s largest and one of its dirtiest power generators – because it was an opportunity to good to refuse.

The purchase, which values the 2,200MW Loy Yang A brown coal power generator at just over $3 billion, will almost treble the emissions intensity of AGL’s portfolio, from 0.36t of Co2 equivalent per megawatt hour, to 1tCo2-e/MWh. Instead of being 56 per cent below the NEM average of 0.9t, it will now be 10 per cent above.

Essentially, AGL Energy is trading its moniker of being the greenest large utility in the country to the lowest cost, an interesting transition given the rhetoric about clean energy futures, and the failure of Australia’s low cost grid to factor in environmental concerns. AGL Energy’s own interim accounts, released today, make much of the fact that AGL Energy has positioned itself to prosper in the low carbon environment by being a leader in clean energy and reducing the emissions intensity of its portfolio. The irony of buying  the country’s largest single emitter is that it will now be in an even better position to prosper, thanks to the structure of the carbon pricing package. And a further irony is that  Loy Yang will continue to generate so much cash flow, even with a carbon price as it is currently set, that AGL Energy says it sees it as its best option to fund its investment in renewable energy in the future.

The opportunity for the purchase was presented by a confluence of events – the Fukushima nuclear disaster last year, the generous support for brown coal generators in the government’s carbon pricing package, which will see Loy Yang A alone get more than $1.2 billion in cash payments and free permits, and the anticipated sharp cost increases for NSW black coal generators as their subsidized source of coal comes to an end. And an expected surge in gas prices.

Fukushima presented an opportunity for AGL Energy because it meant that Tepco, the plant’s operator, was no longer in a position to invest in Loy Yang A and was a distressed seller of its one third stake in Loy Yang A. AGL Energy, which already had a 32.5 per cent stake in the plant, says Loy Yang A will remain one of the lowest cost generators in the NEM because of cheap coal at the doorstep – it pays just $6/t for brown coal, which would give it a massive advantage over black coal generators in NSW, which are facing costs of $45/t and will go higher in future years. It values the low cost source of brown coal alone at $2.4 billion.

Its prediction of “substantial” future gas flows is based on Treasury’s carbon price modeling, which suggests a carbon price of around $40/t out to 2025, and then an assumption that it will flat-line beyond that. AGL expects the plant to continue production at least to 2036, when its contracts with Alcoa concludes.

This Treasury forecast is based on the “550ppm” scenario, rather than a more ambitious abatement task. AGL says brown coal can still spin off cash flow even with a carbon price of more than $50/t, particularly as the cost of gas and black coal is expected to increase dramatically in coming years. Treasury’s “high price” carbon forecast, which takes into account a 450ppm scenario, puts the price of carbon at more than $50/t by 2016, and more than $80/t by 2025, and then continuing to rise sharply in future years.

But the electricity market is betting that won’t happen. Already, futures contracts in the NEM beyond 2013 have virtually ceased, because the market is convinced that Tony Abbott will win the next election and somehow find a way to rescind the carbon price. AGL Energy says there is a high chance that carbon prices will be below the Treasury forecast – a fair bet considering the problems in Europe – and it notes that the transaction will look even more attractive if the Clean Energy Future package were repealed by a future government.

AGL Energy says the cash flow from brown coal will be used to help fund its investment in renewable energy needed to meet the renewable energy target, which calls for 20 per cent of generation to come from renewable sources by 2020. AGL says it needs to spend $4 billion to $5 billion on renewable projects, and wants to build up to 80 per cent of this itself.

It currently has several wind projects under construction, most notably the 440MW Macarthur wind farm in Victoria, which will be the largest in the country, but much of its current development portfolio is based around gas generation, such as 240MW plant near Mt Isa which is to be constructed in place of the “CopperString” project that would have unlocked many renewable resources in northern Queensland, and the Dalton gas plant in the Hunter Valley, as well as a gas storage facility.

AGL will spend $448 million in equity to lift its stake to 100 per cent, and will then negotiate with bankers for a refinancing of the coal mine. It puts the enterprise value of the transaction at $3. Billion. Loy Yang, which supplies 30 per cent of Victoria’s energy needs, delivered a $4.9 million loss in the lastest half (AGL’s share), because of the cost of debt overwhelmed cash flows.